Auditing
A Risk-Based Approach To Conducting A Quality Audit
10th edition
Karla M. Johnstone | Audrey A. Gramling | Larry E. Rittenberg
CHAPTER 12
AUDITING LONG-LIVED ASSETS: ACQUISITION, USE,
IMPAIRMENT, AND DISPOSAL
Copyright © 2016 South-Western/Cengage Learning
LEARNING OBJECTIVES
1.
2.
3.
4.
5.
Identify the significant accounts, disclosures, and
relevant assertions in auditing long-lived assets
Identify and assess inherent risks of material
misstatement associated with long-lived assets
Identify and assess fraud risks of material
misstatement associated with long-lived assets
Identify and assess control risks of material
misstatement associated with long-lived assets
Describe how to use planning analytical procedures to
identify possible material misstatements associated
with long-lived assets
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LEARNING OBJECTIVES
6.
7.
8.
Determine appropriate responses to identified risks
of material misstatement in auditing long-lived
assets
Determine appropriate tests of controls and
consider the results of tests of controls in auditing
long-lived assets
Determine and apply sufficient appropriate
substantive audit procedures in auditing long-lived
assets
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THE AUDIT OPINION FORMULATION
PROCESS
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LEARNING OBJECTIVE 1
IDENTIFY THE SIGNIFICANT ACCOUNTS,
DISCLOSURES, AND RELEVANT ASSERTIONS
IN AUDITING LONG-LIVED ASSETS
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EXHIBIT 12.1 - LONG-LIVED ASSETS:
ACCOUNT INTERRELATIONSHIPS
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SIGNIFICANT ACCOUNTS, DISCLOSURES,
AND RELEVANT ASSERTIONS
• Long-lived assets: Noncurrent assets that are used
over multiple operating cycles and include tangible
and intangible assets
• Tangible assets: Have a physical form
• Machinery, buildings, and land
• Intangible assets: Have a nonphysical form
• Patents, trademarks, copyrights, and brand recognition
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SIGNIFICANT ACCOUNTS, DISCLOSURES,
AND RELEVANT ASSERTIONS
• Other accounts associated with long-lived assets
•
•
•
•
•
Related depreciation or impairment expense
Related gains caused by disposals
Related losses caused by disposals or impairments
Accumulated depreciation account
Depletion expense: Associated with the extraction of
natural resources
• Amortization expense: Process of expensing
acquisition cost minus residual value of intangible
assets over their estimated useful economic life
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RELEVANT FINANCIAL STATEMENT
ASSERTIONS
Existence or occurrence
•Long-lived assets exist at the balance sheet date
•The focus is on additions during the year
Completeness
•Long-lived asset account balances include all relevant transactions that have
taken place during the period
Rights and obligations
•Organization has ownership rights for the long-lived assets as of balance sheet
date
Valuation or allocation
•The recorded balances reflect the balances in accordance with GAAP
Presentation and disclosure
•Long-lived asset balance is reflected on balance sheet in noncurrent section
•The disclosures for depreciation methods and capital lease terms are adequate
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LEARNING OBJECTIVE 2
IDENTIFY AND ASSESS INHERENT RISKS OF
MATERIAL MISSTATEMENT ASSOCIATED WITH
LONG-LIVED ASSETS
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IDENTIFYING INHERENT RISKS
• Asset impairment: Management’s recognition that a
significant portion of fixed assets is no longer as
productive as had originally been expected
• When assets are so impaired, they should be written
down to their expected economic value
• Factors associated with inherent risk related to asset
impairment
• Management is not interested in identifying and writing
down assets
• Management wants to write down every potentially
impaired assetCopyright
to a© 2016
minimum
realizable value
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IDENTIFYING INHERENT RISKS
• Incomplete recording of asset disposals
• Obsolescence of assets
• Incorrect recording of assets due to complex
ownership structures
• Amortization that does not reflect economic
impairment
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AUDITOR BECOMES AWARE OF
INHERENT RISKS
• Knowledge of client’s business, industry trends and
technological advances
• Review of various documents, including:
• Business plan for major acquisitions or changes in the
way a company conducts its business
• Major contracts regarding capital investments or joint
ventures with other companies
• Minutes of board of directors’ meetings
• Company filings with the SEC describing company
actions, risks, and strategies
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INHERENT RISKS ASSOCIATED WITH NATURAL
RESOURCES AND INTANGIBLE ASSETS
Natural Resources
Intangible Assets
• Difficult to identify costs
associated with discovery
• Difficult to estimate
commercially available
resources to be used in
determining a depletion
rate
• Difficult to estimate
reclamation cost when the
client restores the property
• Determination of cost not
straightforward
• Legal costs for obtaining
and defending a patent are
capital expenditures
• Cost of patents should be
amortized over the lesser of
their legal life or their
estimated useful life
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LEARNING OBJECTIVE 3
IDENTIFY AND ASSESS FRAUD RISKS OF
MATERIAL MISSTATEMENT ASSOCIATED WITH
LONG-LIVED ASSETS
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POSSIBLE FRAUD RISK SCHEMES
• Overvaluing existing assets
• Sales of assets not recorded, proceeds misappropriated
• Assets that have been sold remain on the books
• Inappropriate residual values assigned to the assets
• resulting in miscalculation of depreciation
• Amortization of intangible assets miscalculated
• Costs that should have been expensed improperly
capitalized
• Impairment losses on long-lived assets not recognized
• Fair value estimates unreasonable
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LEARNING OBJECTIVE 4
IDENTIFY AND ASSESS CONTROL RISKS OF
MATERIAL MISSTATEMENT ASSOCIATED WITH
LONG-LIVED ASSETS
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TYPICAL CONTROLS AFFECTING MULTIPLE
ASSERTIONS FOR LONG-LIVED ASSETS
• Formal budgeting process with appropriate follow-up
variance analysis
• Written policies for acquisition and disposals of longlived assets, including required approvals
• Limited physical access to assets, where appropriate
• Periodic comparison of physical assets to subsidiary
records
• Periodic reconciliations of subsidiary records with the
general ledger
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OTHER CONTROLS OVER TANGIBLE
ASSETS
• Identify existing assets, inventory them, and
reconcile the physical asset inventory with the
property ledger on a periodic basis
• Provide reasonable assurance that all purchases are
authorized and properly valued
• Appropriately classifying new equipment according
to its expected use and valuation
• Periodically reassess appropriateness of depreciation
categories
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OTHER CONTROLS OVER TANGIBLE
ASSETS
• Identify obsolete equipment and write the
equipment down to scrap value
• Review management strategy and systematically
assess impairment of assets
• Use serial numbered asset tags, with bar codes for
tracking the location, quantity, condition,
maintenance, and deprecation status of assets
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CONTROLS OVER ASSET IMPAIRMENT
JUDGMENTS
• Systematically identify assets that are not currently
in use
• Projections of future cash flows, by reporting unit,
that are based on management’s strategic plans and
economic conditions
• Systematically develop current market values of
similar assets prepared by the client
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CONTROLS
Over Natural Resources
• Develop procedures and
associated internal controls for
identifying costs
• Use geologists to establish an
estimate of reserves contained
in a new discovery
• Reassess the amount of
reserves as more information
becomes available during the
course of mining, harvesting,
or extracting resources
Over Intangible Assets
• Provide reasonable assurance
that decisions are appropriately
made as to when to capitalize or
expense research and
development expenditures
• Develop amortization schedules
reflecting the remaining useful
life of patents or copyrights
associated with the asset
• Identify and account for
intangible-asset impairments
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LEARNING OBJECTIVE 5
DESCRIBE HOW TO USE PLANNING ANALYTICAL
PROCEDURES TO IDENTIFY POSSIBLE MATERIAL
MISSTATEMENTS ASSOCIATED WITH LONG-LIVED ASSETS
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RATIO AND TREND ANALYSES
• Review and analyze gains/losses on disposals of
equipment
• Perform an overall estimate of depreciation expense
• Compare capital expenditures with the client’s
capital budget
• Compare depreciable lives for various asset
categories with those of the industry
• Compare the asset and related expense account
balances in the current period to similar items in the
prior audit
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OTHER RATIOS TO USE IN PLANNING
ANALYTCIAL PROCEDURES
• Ratio of depreciation expense to total depreciable
long-lived tangible assets
• Ratio of repairs and maintenance expense to total
depreciable long-lived tangible assets
• Long-lived assets to total assets
Ratio analysis should involve comparison of the
unaudited financial statements with both past results
and industry trends, considering auditor expectations
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PLANNING ANALYTICAL PROCEDURES
If planning analytical
procedures do not identify any
unexpected relationships
Auditor would conclude that
there is not a heightened risk of
material misstatements in these
accounts
If unusual or unexpected
relationships exist in planning
analytical procedures
Planned audit procedures
would be adjusted to address
the potential material
misstatements
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LEARNING OBJECTIVE 6
DETERMINE APPROPRIATE RESPONSES TO
IDENTIFIED RISKS OF MATERIAL MISSTATEMENT
IN AUDITING LONG-LIVED ASSETS
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RESPONDING TO IDENTIFIED RISKS OF
MATERIAL MISSTATEMENT
• Developing an audit approach that contains tests of
controls (if applicable) and substantive procedures
• If client’s controls related to long-lived assets are
effective auditor can primarily rely on substantive
analytical procedures
• Auditors should customize their standardized audit
program based on the assessment of risk of material
misstatement and client-specific conditions
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CLIENT-SPECIFIC CONSIDERATIONS
• Organizations having only a few assets of relatively
high value
• Use of substantive approach, using tests of details, for
obtaining evidence rather than performing tests of
controls
• Organizations having a high volume of long-lived
asset transactions
• Perform tests of controls to support a moderate- or
low-assessed level of control risk and then reduce
substantive testing
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12-29
LEARNING OBJECTIVE 7
DETERMINE APPROPRIATE TESTS OF CONTROLS
AND CONSIDER THE RESULTS OF TESTS OF
CONTROLS IN AUDITING LONG-LIVED ASSETS
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EXMAPLE: PERFORMING TESTS OF
CONTROLS
• CONTROL: Assume that a client implements a policy
requiring the establishment and enforcement of
property management training. Auditor tests could
include:
• Inquiry - Inquire about the nature of training to a
select sample of personnel
• Observation - Observe property management actions
in process
• Inspection of documentation - Review documentation
showing completion of the training
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12-31
OUTCOMES OF THE RESULTS OF TESTS
OF CONTROLS
Assess those deficiencies to determine their
severity
If control
deficiencies
are identified
Modify the preliminary control risk
assessment
Document the implications of the control
deficiencies
Auditor
analyzes
results of tests
of controls
Determine whether the preliminary
assessment of control risk as low is still
appropriate
If no control
deficiencies
are identified
Determine the extent that controls can
provide evidence on the correctness of
account balances
Determine planned substantive audit
procedures
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LEARNING OBJECTIVE 8
DETERMINE AND APPLY SUFFICIENT
APPROPRIATE SUBSTANTIVE AUDIT
PROCEDURES IN AUDITING LONG-LIVED ASSETS
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ASSURANCES REQUIRED BY AUDITOR IN
PERFORMING SUBSTANTIVE PROCEDURES
• Long-lived assets reflected in balance sheet exist
• Organization has rights of ownership to recorded longlived assets
• Long-lived assets include all relevant items, including
those that are purchased, contributed, constructed inhouse or by third parties, and leases meeting the
criteria for capital leases
• Long-lived asset additions are recorded correctly
• Items to be capitalized are identified and distinguished
from repairs and maintenance expense items
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ASSURANCES REQUIRED BY AUDITOR IN
PERFORMING SUBSTANTIVE PROCEDURES
• Depreciation/amortization/depletion calculations are
made and based on appropriate estimated useful
lives and methods
• Retirements, trade-ins, and unused property and
equipment are identified and recorded correctly
• Long-lived assets and related expenses are
appropriately presented in the financial statements
with adequate disclosures
• Fraudulent transactions are not included in the
financial statements
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SUBSTANTIVE ANALYTICAL
PROCEDURES
• Before performing tests of details related to longlived assets, the auditor may perform substantive
analytical procedures
• The use of substantive analytical procedures will be
most appropriate when the risk of material
misstatement is low.
• Analytical procedures will likely incorporate:
• Reasonableness test of depreciation
• A number of relevant ratios
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SUBSTANTIVE TESTS OF DETAILS FOR TANGIBLE
ASSETS - TESTING CURRENT PERIOD ADDITIONS
• Auditor examines supporting documentation of
individual long-lived asset transactions by examining
a schedule of additions
• After the schedule is agreed to the general ledger,
auditor selects sample items for testing
• Auditor determines that capitalized additions were
appropriate and that none of them should have been
expensed as repairs and maintenance or other costs
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SUBSTANTIVE TESTS OF DETAILS FOR TANGIBLE
ASSET - TESTING CURRENT PERIOD DELETIONS
• Auditor should:
• Trace original cost of item and its accumulated
depreciation to supporting documentation
• Recompute any gain or loss to determine whether it is
accounted for in conformity with GAAP
• Perform procedures to search for any unrecorded
disposals
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SUBSTANTIVE PROCEDURES RELATED TO DEPRECIATION
EXPENSE AND ACCUMULATED DEPRECIATION FOR
TANGIBLE ASSETS
• Objective in testing depreciation is to determine
whether:
• The client is following a consistent depreciation policy
• Unless client has reasonable justification for changing
methods
• The client’s calculations are accurate
• Management’s estimates are reasonable
• If low risk of material misstatement, auditor may rely
primarily on substantive analytical procedures
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SUBSTANTIVE TESTS OF DETAILS:
DEPRECIATION EXPENSE AND
ACCUMULATED DEPRECIATION
• Start with the long-lived asset ledger
• Use GAS
• Foot the long-lived asset ledger, match it to the general
ledger
• Identify all entries into the depreciation and
accumulated depreciation accounts coming from other
than normal depreciation entries and asset disposals
• Sample items contained in detailed property ledger
• Recalculate depreciation for items chosen
• Project differences to the population
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SUBSTANTIVE TESTS: NATURAL
RESOURCES
• Test the capitalization of all new natural resources
• Verify the costs by examining documents including
client’s own process of documenting all the costs of
exploration and drilling
• Substantiate the amount of items sold during the
year
• Consider using an auditor specialist/expert to
perform additional analysis and/or review the client’s
analysis
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SUBSTANTIVE TESTS: INTANGIBLE
ASSETS
• Review appropriate documentation
• Inspect relevant documentation
• Test management’s calculation of any gain/loss on
disposal of assets; determine proper reduction of
carrying amounts
• Determine whether amortization expense is accurate
and whether amortization policy and useful lives are
reasonable and consistent with prior years
• Inquire of management whether circumstances
indicate that the carrying amounts of intangibles may
not be recoverable
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SUBSTANTIVE PROCEDURES RELATED
TO ASSET IMPAIRMENT
Auditor needs
reasonable
assurance that:
• Long-lived assets are valued at their
economic benefit to the organization
• When value has been impaired, the
organization has written down the
asset
If there is evidence
that an asset has
been impaired,
auditor needs to
address the
valuation issue
• Understand the process for assessing
impairment
• Evaluate reasonableness of
management’s assumptions
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SUBSTANTIVE PROCEDURES RELATED
TO LEASES
• Obtain copies of lease agreements, read the
agreements, and develop a schedule of lease
expenditures
• Review lease expense account, select entries to the
account, and determine if there are entries that are
not covered by leases obtained from client
• Determine if expenses are properly accounted for
• Review relevant criteria from the FASB’s codified
standards (ASC) to determine which leases meet the
requirement of capital leases
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SUBSTANTIVE PROCEDURES RELATED
TO LEASES
• For all capital leases, determine that assets and lease
obligations are recorded at their present value
• Develop a schedule of all future lease obligations or
determine whether client’s schedule is correct by
referring to underlying lease agreements
• Review client’s disclosure of lease obligations to
determine that it is in accordance with GAAP
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PERFORMING SUBSTANTIVE FRAUDRELATED PROCEDURES
• Physically inspect tangible assets and agree serial
numbers with supporting documentation
• Request client to perform a complete inventory of
long-lived assets at year end
• Scrutinize appraisals and other specialist reports that
seem out of line with reasonable expectations, and
challenge the underlying assumptions
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PERFORMING SUBSTANTIVE FRAUDRELATED PROCEDURES
• Use the work of a specialist for asset valuations and
impairments
• When vouching long-lived asset additions, accept
only original invoices, purchase orders, receiving
reports or similar supporting documentation
• Confirm terms of significant additions of property or
intangibles with other parties involved
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DOCUMENTING SUBSTANTIVE
PROCEDURES
• For tangible assets
• Summary schedule showing:
• Beginning balances
• Additions and deletions
• Ending balances for the asset account and for
accumulated depreciation
• Identification of the specific items tested
• For intangible assets - Evidence supporting review of
the reasonableness of their continuing value
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